Don't Miss This Cheap Stock

Unfortunately, "cheap" is a relative term. Precious few stocks that trade for low price-to-earnings ratios or below book value are real bargains. They look enticing, but instead, they're value traps -- stocks that deserve the multiples for which they trade, and punish the garbage-grabbers who buy them.

But don't take my word for it. Here are five "cheap" stocks that trapped bargain-hunting prey:

Watch out!How can you avoid value traps like these? My favorite method is borrowed from professor Aswath Damodaran. In his book Investment Fables, Damodaran counsels investors to measure low price-to-book stocks by their returns on equity (ROE).

Makes sense to me. "Book value" is shorthand for equity. A low price-to-book stock is priced as if management won't produce high returns from the equity capital afforded it. Find a stock that defies this maxim -- a stock with an above-average and rising ROE -- and you may have found a bargain.

A machete when you're in the weedsOur 140,000-member-strong Motley Fool CAPS database is a great place to start your search. I ran a screen for well-respected stocks trading for less than twice book value, and whose returns on equity were 10% or more. Qualifiers were also trading no more than 25% above their 52-week low, leaving plenty of room for further gains.

Of the 16 stocks that CAPS found hiding in the weeds, The Ensign Group (Nasdaq: ENSG) intrigues me this week. The details:

Not long ago, Fools saw this operator of long-term care facilities as a stock poised to pop. And that still seems to be true. All 64 the top CAPS investors rating Ensign -- Fools whose picks have performed better than 80% of the broader community -- say this stock will outperform, a good sign.

What do these experts see? "Long term play on long term care," wrote former Top Fool tenmiles in May. "Recent weakness in stock likely provides a good fundamental and technical entry point for this small cap, health consolidator with attractive growth. Buyer at $13.20."

He's up about 7% since, a market-lagging performance. The good news? At 9.5 times earnings, the stock trades for less than its industry average multiple, and for far less than larger peers, such Kindred Healthcare (NYSE: KND) . I'd be a buyer at these levels.

But that's also just my take. Would you buy shares of The Ensign Group at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

Want further guidance? Get 30 days of free access to the Fool'sInside Valueservice, which spotlights stocks that Mr. Market has put on sale. Try any of our Foolish newsletter services free for 30 days.

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment.